Markets relieved as budget doubles fiscal headroom

Highlights: The UK Budget has eased near-term fiscal concerns by increasing headroom to around GBP22 billion, helping reassure markets that the government can manage its borrowing needs without triggering fears of instability. Chancellor Reeves will take comfort in the market reaction as gilt yields fell and GBP rose, implying that investors received the message on fiscal sustainability and expected volatility eased. We currently favour high quality IG corporate bonds while gilts should eventually benefit from extended rates cuts through 2026. There were winners and losers across the UK equity market, where we stay neutral.

• Now that the event risk of the budget is in the rearview mirror, markets likely benefitted from a bump from lower expected volatility. Investors will now pay close attention to upcoming surveys on economic sentiment to see whether some of the economic gloom has lifted
• Slowing wage growth should help keep inflation on a downward trajectory, especially as the labour market becomes less tight with vacancies continuing to normalise. But this also reduces income support for consumption at a time when productivity growth has been disappointingly flat. The persistent gap between real borrowing costs and productivity highlights the structural obstacles facing the UK economy
• Markets are increasingly pricing the first Bank of England (BoE) rate cut around year-end, although opinions differ on timing. Our view leans toward February 2026, as the BoE will want more confidence that disinflation is firmly embedded across services and labour-driven components
• Against this backdrop, gilts appear relatively well-positioned for 2026, with the scope for yields to decline further as macro uncertainty persists and fiscal tightening eventually gains traction. In contrast, UK equities continue to trade at wide discounts to global peers but lack immediate catalysts for re-rating. Investor appetite may remain selective, favouring more defensive exposures until confidence in the growth outlook begins to improve
• Overall, while the Budget reduces tail risks and confirms a commitment to fiscal responsibility, economic momentum remains fragile. However, clearer signs of sustained real income gains, improved productivity and stabilising sentiment will be needed to support a more constructive stance on UK risk assets

HSBC’s investment services draw on these developments to help investors navigate opportunities and risks as the outlook for UK assets continues to evolve.